Citi recommends car parts dispersion play

In its latest High yield weekly report, Citi recommends buying credit default swap protection on ArvinMeritor and going long Allison Transmission by selling LCDS protection on the name. The report notes that ArvinMeritor has been active lately as short-sellers have been covering their positions in the wake of better than expected second-quarter earnings. But Citi says there is still a significant amount of execution risk in the credit, which is struggling to stay in compliance with its covenants.

Fellow parts maker Allison is better positioned to grow internationally with a presence in China, India and Russia, than ArvinMeritor, which gets one-third of its sales from Europe.

Citi’s analysts recommend going long Allison’s loans through credit derivatives despite the cancellation risk inherent in an LCDS contract. They point out that at 16 point up front, protection sellers collect most of the potential upside on day one. The cost of buying five-year protection on ArvinMeritor unsecured is 17 points up front.